The Importance of Benchmarks

The Importance of Benchmarks

If I was to ask you how your company is performing, what would you say? If I was to guess at what you would say it may sound something like the following – “We are doing pretty well, you know how it is.” Now, that’s not necessarily a wrong answer, but it most definitely lacks for specifics.

What is the reply from our business owner missing? First of all “pretty well” is vague, to say the least, and the second part of the response leaves much to the imagination. This answer makes the asker exert additional mental energy to try and figure out what “pretty well” means and leaves them to draw their conclusions.

So, how can the response be improved? Well, we first need to add a bit of context. The context, in this case, is to unpack “pretty well” and determine what that means exactly.

That’s where benchmarks come into play.

A benchmark is merely a comparison point based calculated from a defined sample. In other words, a benchmark provides context that allows us to assess how something is performing or improving compared to others.

In this post, we are going to unpack benchmarks a bit more and take a look at why they are essential to your small business.

Relative Performance

Describing a company’s current performance as “pretty well” is a weak answer. It inevitably leads to the follow-on question of “Well, compared to what?” which leaves the asker looking for more.

When you dig a bit deeper, the real question is actually “How is your company performing relative to the peers in your industry?”

But how does one go about determining relative performance?

Benchmarks are clearest and most reliable way to answer the underlying question. By comparing a company’s performance to a benchmark, it allows for an intuitive and quick determination.

So, what does this look like in practice? By adding a benchmark metric as a relative comparison point when asked the performance question, any ambiguity is removed.

A better answer to the performance question using a benchmark could go something like this –

“Well, our net profit margin last quarter was 12% as compared to the industry benchmark of 8%, so you could say we are doing pretty well.”

See how much clearer that answer was? The answer leaves me with very little doubt as to what “pretty well” means.

So benchmarks are a great way to assess relative performance quickly and intuitively.

Trending

One potential pitfall of using benchmarks in the way I did above is that it only references a single data point. Referencing one data point to assess performance can be deceiving. A data point even in context can paint a picture that may not be actual reality.

Trending can help shed a bit more insight into our relative comparison.

A trend is just the tracking of a metric or set of metrics using the same calculation methodology over a period. Using the same calculation methodology is a critical distinction. A trend becomes worthless if it is not apples to apples and using varying methods. This topic is worthy of an entire post, but I will leave it there.

For example, by trending the metric of net profit margin over a period, we can add even more context and gain additional insight into how the company is doing.

Reframing the answer to the performance question with trending could be:

“Well, our net profit margin last quarter was 12% as compared to the industry benchmark of 8%. But as compared to the same quarter last year it is lower by 2%. So you could say we are doing pretty well compared to our peers, but we have some work to do.”

Adding the trending comparison of quarter over quarter gives much more context to the answer, and now we truly understand how the company is performing.

Targets and Goals

Having a baseline for relative performance using benchmarks and trending lends itself well to creating targets and goals.

Targets are the level to which a metric must reach to satisfy performance expectations. Using the previous example, the company’s net profit margin was 14% last quarter while their current quarter’s net profit margin was lower at 12%.

Now, a target can be more refined that by taking into account market conditions, etc. But for this illustration lets use 14% as our target. Meaning that the minimum performance expectation was to meet the 14% as achieved during the prior year. So, the company did not meet their performance target.

A goal uses a target as its base but takes it one step further. A goal should be aspirational. At the end of the day, a company needs to grow to survive and merely setting the company’s sights on a target is necessary, but insufficient.

Having a goal that is higher than the target creates a culture of forward-progress rather than static regression. Meaning that if you want to grow then, build-in a goal that if you achieve it, leads to growth.

Using benchmarks and trending is a great way to calculate potential targets as well as goals for your organization.

Takeaways

Having context for any performance measurement is crucial. The best way to do that is by employing both benchmarks and trending.

In the examples above, we added relative comparison benchmarks from an industry and period perspective. But, you can use a variety of benchmarks that could be based on internal, company-specific measurements.

An internal benchmark may be the average net profit margin over a period of 6-months for example. So your target could be that metric, and your goal may be an incremental adder on top of the target.

So where to start? I would begin internally and look to establish internal benchmarks for each metric you track and especially any KPIs. This way you can build targets and goals.

You can then take one step further by adding industry benchmarks to inform your company’s performance even more. Bookvalu has several appropriate industry benchmarks built-in to help you with relative comparisons.

One last takeaway – benchmarks, targets and goals don’t need to be limited to financial metrics. They can be used for production, productivity, sales and in several other categories of metrics. Be creative, but always use consistent calculation methodology to get an accurate representation.

Bookvalu is QuickBooks Forecasting, Ratio Analysis, and Valuation software that provides financial visibility and insight for your Small Business.